Why is the Rupee Weakening Against the Dollar?

Sub: Eco

Sec: External sector

Context and Current Status

The rupee breached the 85 marks against the U.S. dollar in December 2024, reaching an all-time low of ₹85.81.
The currency depreciated by about 3% in 2024, continuing its long-term trend of gradual depreciation.

Factors Behind Currency Depreciation

Forex Market Dynamics: A currency depreciates when its demand (relative to its supply) decreases in the forex market.
Type of Monetary Policy followed by Central Banks:
- Loose Monetary Policy: Increases currency supply, depreciating its value.
- Tight Monetary Policy: Restricts currency supply, appreciating its value.
Demand for Goods and Assets:
- High demand for a country’s goods or assets boosts currency value.
- Declining demand reduces the currency’s value.

Current Drivers of Rupee Depreciation

Foreign Investor Exit:
- Global investors are reallocating funds as central banks adjust monetary policies.
Monetary Policy Divergence:
- The Reserve Bank of India (RBI) maintained a looser policy compared to the U.S. Federal Reserve.
India’s Import-Export Dynamics:
- High-value Imports: Crude oil and gold imports increase demand for the dollar.
- Stagnant Exports: Limited export growth fails to generate demand for the rupee.

Role of the Reserve Bank of India (RBI)

Market Intervention and Exchange rate management:
- The RBI used dollar reserves to stabilize the rupee, injecting dollars into the forex market to meet demand.
- RBI aims for gradual rupee depreciation with minimal volatility to safeguard economic stability.